The end of noting of interest: disturbing the lull of false security
The Association of British Insurers (ABI) ended the longstanding protocol with the British Bankers' Association (BBA) that had been designed to protect banks' interests as mortgagees of property in June this year. The ABI and BBA are not replacing the protocol with any similar arrangement.
This article explains what the agreement covered and what it did not. It also suggests how lenders will now be seeking to protect their interests and what the implications may be.
The ABI/BBA Agreement
In 1992, some of the major UK insurance companies, represented by the ABI, made an agreement with a number of UK banks (represented by the BBA). The effect of the agreement was that the insurers agreed they would:
- Advise the bank if the policyholder did not renew the policy;
- Advise the bank if the policyholder reduced the insurance cover, or any risk previously covered was restricted or cancelled; and
- Keep the bank's interest in the policy in force, provided the bank agreed to pay the premium.
The agreement aimed to reduce the administration for insurers (who had previously had to produce separate endorsements dealing with the banks’ interests). It also aimed to provide a safety net for the banks if they failed to make specific arrangements to ensure they could rely on the insurance cover.
What did "noting of interest" mean in practice?
In truth, not much. Many lenders wrongly believed that a "noting of interest" gave them a security interest in the insurance policy. Others thought it put them in the same position as a loss payee. The benefits of having an interest "noted" are, in reality, very limited. Having an interest "noted" did not by itself give the bank any right to enforce the policy or entitle it to payment of the proceeds of any insurance claim. It also gave the bank no priority over other creditors if the borrower became insolvent.
So what happens next?
Now that the agreement has gone, however, lenders may be spurred into looking at methods of protecting their interest that will be more effective.
There are different ways for lenders to try to ensure they will get access to insurance proceeds if there is a claim. Not all are available, or suitable, for every transaction. As we will see, however, this may end up placing an extra burden on the insured borrowers.
The options available
A lender may have a number of options to protect its interest in its borrower's insurance policy, including establishing a trust over the insurance proceeds or relying on the (limited) circumstances in which third parties can enforce rights under contracts. This note, though, will focus on the following three methods, likely to be the most common in practice:
- Being named as a co-assured on the policy, which gives the bank direct rights under the policy – but by definition involves the bank being a party to the policy;
- Taking a security assignment of its borrower's right to be indemnified under the insurance policy, which gives the bank a direct right of action in the event of a claim under the policy, though the bank will not have rights under the policy; and
- Being named as loss payee in the policy, which simply means that the insurer can validly pay the claim sum to the bank.
Some can be used in tandem, but not all are available for every transaction or every policy. And not all methods of "sharing" the benefits of insurance provide equal protection.
Impact on the borrower
From a bank’s perspective, being a co-assured is likely to afford most protection, followed by taking a security assignment. From the borrower’s perspective, though, the loss payee route might be preferable. Co-assurance and security assignments are beneficial to banks partly because they provide the bank with a direct right against the insurer, increasing the bank’s control in a claim situation. Of course, the corollary is that the borrower’s control is reduced or even excluded. Banks typically look to achieve a quick payout, speed of recovery often being preferred over maximising the amount. The borrower, on the other hand, may want to play a longer game, in order to maximise the recovery. In addition to loss of control, the other downside may well be costs: in the event of an unsuccessful action to enforce a claim under the policy, the bank may be ordered to pay the insurer’s costs, but the bank may well look to the borrower to pay the bill. Where the bank brings the action in the borrower’s name, the costs order will be made directly against the borrower.
In contrast, where the lender is just a loss payee, the borrower will still control any claim under the policy, also giving it control of costs.
Another potential drawback of the co-assurance route is that negotiating the inclusion of the bank as a co-assured is likely to complicate the policy: for example, the bank will want the policy wording to be adapted to protect its position, including ensuring that its rights under the policy are not prejudiced by anything the borrower does. Complications invariably result in higher costs, and banks invariably want the borrower to pay those costs.
Where the bank takes a security assignment, it will not have protection from acts or omissions of the borrower prejudicing rights under the policy. As a result, the bank will probably want an indemnity from the borrower to cover any loss of insurance caused by something done, or not done, by the borrower. The same will apply to those situations where the bank is going to be a loss payee.
The end of the ABI/BBA agreement may therefore wake lenders from their lull and insureds can expect that banks may take a more hands-on approach to insurance policies. The insured will need to understand the legal framework relating to insurance so it can consider what form of bank involvement it would prefer and how to manage the cost of that bank involvement.
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